Problem 1: Wolfson Corporation has decided to purchase a new machine that costs $3.2 million. The machine will be depreciated on a straight-line basis and will be worthless after four years. The corporate tax rate is 35 percent. The Sur Bank has offered Wolfson a four-year loan for $3.2 million. The repayment schedule is four yearly principal repayments of $800,000 and an interest charge of 9 percent on the outstanding balance of the loan at the beginning of each year. Both principal repayments and interest are due at the end of each year. Cal Leasing Corporation offers to lease the same machine to Wolfson. Lease payments of $950,000 per year are due at the beginning of each of the four years of the lease.

a. Should Wolfson lease the machine or buy it with bank financing?

b. What is the annual lease payment that will make Wolfson indifferent to whether it leases the machine or purchases it?

Problem 2: An asset costs $620,000 and will be depreciated in a straight-line manner over its three-year life. It will have no salvage value. The lessor can borrow at 7 percent and the lessee can borrow at 9 percent. The corporate tax rate is 34 percent for both companies.

a. How does the fact that the lessor and lessee have different borrowing rates affect the calculation of the NAL?

b. What set of lease payments will make the lessee and the lessor equally well off?

c. Assume that the lessee pays no taxes and the lessor is in the 34 percent tax bracket. For what range of lease payments does the lease have a positive NPV for both parties?